BlackBerry: The Deceptive Value of Cash

It's always a good thing when a company is sitting on a lot of cash. It brings stability to the balance sheet, protecting the company against short-term problems. It also lowers the company's enterprise value, thus making the stock less expensive than traditional valuation metrics suggest. But sometimes large amounts of cash can blind investors, causing them to ignore serious long-term problems with the company. Troubled phone maker BlackBerry (NASDAQ: BBRY) offers a glaring example of exactly that.

Worth more dead than alive The bull argument for BlackBerry earlier this year sounded compelling. Even with new phones selling poorly the company had about $3 billion in cash, no debt, and a significant patent portfolio. At a price of $9 per share, where it traded in July, this cash represented nearly two-thirds of the total market capitalization. The argument, then, was simple--the patents were surely worth more than the market cap minus the cash.

The problem with that argument is that it valued the company as if it were going to be liquidated. If BlackBerry were to cease operations and liquidate, the result would have likely lead to more than $9 per share in proceeds. But BlackBerry is a going concern, and as such, its earnings matter. And those earnings are extremely negative.

In the fiscal year which ended in February the company lost about $640 million. Then, earlier this month, the company cut a third of its workforce and warned of an operating loss of close to $1 billion for the quarter, although some of this was due to writedowns.

These losses, which don't appear to become profits anytime soon, make BlackBerry worth far more dead than alive. Investing based on the liquidation value, especially when the argument is largely based on cash, when the company is operating at a huge loss is not a particularly good idea.

It's not surprising that the only buyout offer received was for $9 per share. The risk would be far too great to convince lenders to participate at a higher price. Those expecting a higher bid will likely be disappointed, since no one in their right mind would buy a failing company that's burning through cash for anywhere near the true liquidation price. My advice to BlackBerry investors, especially those who bought in at much higher prices--accept your losses and move on.

Cash and profits-a winning combination If your main argument for investing in a company is its cash balance, there better be sustainable profits, or at the very least a reasonable expectation of future profits, to back it up. This was the missing piece of the puzzle for BlackBerry investors, and they paid dearly for it. A company like networking giant Cisco Systems (NASDAQ: CSCO) , on the other hand, has both a lot of cash and extremely profitable operations.

Cisco is sitting on $34.4 billion in net cash, about a quarter of the company's total market capitalization. This reduces the enterprise value to just about $100 billion, reducing valuation metrics like the P/E ratio by 25% (ex-cash). What was a 13 P/E ratio stock is really a 10 P/E ratio stock (ex-cash).

What's more, Cisco is still growing. Its core markets are fairly mature, growing in the low-single digits annually, but the company is acquiring its way into new growth markets which have huge potential. Back in July Cisco acquired Sourcefire, a network security company, a move which solidifies Cisco's position in the fast-growing market. Earlier this month the company made another big acquisition, cloud flash storage company Whiptail, in a foray into the storage market. Of course, the success of these acquisitions is far from guaranteed, but Cisco is positioning itself for continued growth.

The bottom line Cisco has three things going for it: a lot of cash, a profitable core business, and fast-growing new businesses. BlackBerry has only cash. And because it's missing the other two, that cash will quickly be eaten away, leaving behind a BlackBerry which is a shell of its former self. This was clear to me throughout BlackBerry's struggles, and now it's become clear to everyone. BlackBerry was a value trap, seducing investors with its cash and patents, only to burn them later. Take the money and run, BlackBerry investors. There will almost certainly be no better deal.

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